Directors’ loan accounts are a notoriously complicated issue for company directors to understand.
Essentially, unlike sole traders or partnerships where taking money from the business is a straightforward process, withdrawing money from a company is very different. Because the company is a separate legal entity, taking money from it requires more consideration and is also open to more scrutiny.
So, what is a director’s loan account? And how does it work? Read on to find out.
Here’s everything you need to know about director’s loan accounts:
What is a director’s loan account?
To put it simply, a director’s loan account (DLA) is basically a record of transactions between a company and its directors, excluding salary and dividends. If you don’t take money out of the company (apart from through dividends or payroll) your loan account will have a balance of zero.
If you have put your own money into the company to fund trading activities or the purchase of assets, the account will be in credit and the director becomes a creditor of the company.
However, if a director borrows money from the company that amounts to more than they have put in, this is known as an overdrawn director’s loan and the director becomes a debtor of the company – and this is where things become more complicated.
What does it mean if the account is overdrawn?
When a director takes money out of a company that isn’t classed as a dividend or a salary and the figure exceeds the value of the money you have put into it, the account becomes overdrawn. At this point, you will be deemed to be benefitting from a director’s loan, and as such, it is classed as a taxable benefit.
If you owe your company over £10,000 at any given time, the loan is classed as a benefit in kind and you’ll need to record it on a P11D, as it’ll be liable to both personal and company tax. Your company will also need to pay Class 1A National Insurance at the 13.8% rate on the full amount.
However, having an overdrawn director’s loan account isn’t the end of the world – particularly if you keep track of all money owed to the company and you can afford to repay it. But if you cannot repay the loan on time (i.e., within nine months of your company’s yearend) that is where things start to get tricky.
Tax implications
If the loan is repaid within nine months of the company’s yearend, there is usually no impact for the director or the company. However, if the director cannot pay the loan back in this time, or if the amount borrowed is more than £10,000, this is when issues can begin to occur.
Because HMRC won’t view your director’s loan as personal income because it is a company asset owed to the business, there are a specific set of rules – namely, Section 455 or S455 which charges tax at a rate of 25%. If the S455 tax is paid on time, the tax payment is refundable.
However, it’s a long and drawn-out process with repayment deferred until nine months after the end of the accounting period in which the loan is repaid.
If you have an overdrawn DLA and you are unable to repay it nine months and one day after your company’s yearend, HMRC will also charge the company interest on the loan until the S455 tax or the DLA is repaid – and whilst you can reclaim the corporation tax at a later date, you cannot reclaim the interest paid on it (3.25%).
Overdrawn loan accounts and insolvency
If a company becomes insolvent, overdrawn director’s loans can become a sticky subject. When businesses face insolvency due to financial problems, around 80% of cases will feature a director with an overdrawn DLA.
After all, it’s pretty common for a director to help themselves to money from the company with the view to paying it back in the long term, especially if things are a bit tight – only for the company to fall into difficulty.
When a company becomes insolvent, you should stop trading immediately. In this situation, there’s no money coming in, but the loan is still outstanding – and if you are unable to repay your overdrawn loan back into the company, this is likely to have an impact on your creditors.
The overdrawn director’s loan account would be considered a company asset that the liquidator would almost certainly pursue – which means that as a director, you could need to personally repay it in order to satisfy creditors.
Unless you can repay the loan, you might even have to enter into a personal insolvency procedure such as bankruptcy. What’s more, if your company has been served a winding up petition, you could even end up being accused of wrongful trading which could have serious consequences, including disqualification.
Top tips on how to manage your account
Of course, when it comes to managing your DLA, the best course of action for a director is to keep an organised track of the account. This means that any money put into the business and any money taken out is all well documented and not allowed to spiral out of control.
In addition, never borrow more than £10,000 from the company unless you have shareholder approval. If you do borrow money, make sure you have a clear plan or structure on how to repay the loan – and make sure it features in the annual accounts or the balance sheet.
Want to learn more?
If you have any more questions surrounding what is a director’s loan account or if you need help and advice on how to manage your DLA account, contact McAlister & Co today.
As one of the UK’s leading insolvency practitioners, if you are struggling to keep your DLA in check, we can provide expert advice to help get you back on track. Remember – the sooner you seek advice, the more options you will have.
